You may have heard your colleagues talk about the 20/4/10 car rule, and probably wondered what it was. Perhaps, you just came across it randomly or your car dealer had just mentioned it superficially to you.
Well, whatever way you got to learn about it, is just about to count when we help you to fully understand what it entails in our well researched article on the topic. The 20/4/10 car rule, has proven beneficial to thousands of persons who adopt it and you may just be next.
Imagine you want to buy a car, but in a sea of options, you are lost on what choice to opt for that is within your budget and yet still meets taste. The 20/4/10 car rule can help you make better choices on your ideal car, help you know if it is a reasonable purchase or opt for a similar less expensive but durable version. For more knowledge. Keep reading!
What is the 20/4/10 Car Rule?
This is about the first and most frequently asked question by almost everyone who just got aware of the term. In simple terms, we define the 20/4/10 car rule as, a guideline that governs car purchases for those who do not intend or have the full amount to pay for their car purchase at once. This rule is designed and expressly guide them on how to pay for the car smartly by following a simple 20/4/10 plan which includes making a 20% down payment on the car, and 4 years to complete the car loan payments, and keep your transportation costs under 10% of your monthly income.
The rule helps in determining the amount of a down payment, the amount the buyer will pay monthly and at what time frames, including the transportation costs, as created by financial experts to help people buy cars with less risk.
How the 20/4/10 Car Rule Works
You may need to make a down payment of 20% or more when purchasing the car
You may need a car loan with a term of 4years or less. Usually, you may also need total transportation cost to be less than 10% of your monthly income
- First, you need to know exactly how much the car you wish to buy is worth. so you can accurately calculate how much a 20% down payment would be.
- Next, you have to figure out how much you’d need to finance and get an estimated interest rate. Then with this information you can have the monthly loan payment, including the interest costs attached.
- Next, calculate the total transportation costs of the car for a month. This costs will include details such as insurance, fuel, taxes and fees, maintenance, etc. Depreciation cost is left out, while calculating.
- Lastly, divide the total cost of the vehicle by your monthly income. Since, the 20/4/10 rule fails to state if this should be your net income (after taxes and deductions) or your gross income (before taxes and deductions), use your intuition.
Benefits of the 20/4/10 Car Rule
First, it helps ascertain that you can afford a down payment on the car you wish to purchase.
Also using a 4-year time frame, it can help you limit the interest you pay if the years were extended, because you’d pay off the loan a lot faster.
Also, when your total transportation costs is about 10% of your monthly income it can help ensure owning a car doesn’t dominate your budget and allow you the means to cater for other expenses.
Typically, the 20/4/10 rule can help you from overextending yourself when purchasing a car. For financially established individuals, it may make sense to consult this rule for a reasonability check before buying a car.
Cons Of The 20/4/10 Car Rule
It’s important to note that this rule is far from perfect. Unfortunately, it’s a longstanding rule that fails to consider the lack of significant wage growth compared to high inflation in the new car market. The U.S. household median income for 2010 was $49,276, which increased to $67,521 in 2020. This represents an increase of 37%. At the same time, the average price of a new car rose from $24,296 in 2010 to $40,107 at the end of 2020. That’s an increase of almost 61%.
Therefore it is important to know when to apply this rule and when to opt for other methods that are more effective. Especially, for persons whose income are of the average or below average, this rule may not be a very smart choice for you.
Tips to stay within the 20/4/10 Rule
If you want to stick to this rule, here are a few ideas that may help:
- Make a larger down payment
- Buy a base model rather than an upgraded model
- Consider last year’s leftover new car inventory
- Purchase a used car instead of a new car
- Keep your current car longer and set aside what would be your monthly payment until you can save more for a better vehicle
- This rule may make sense in your situation, or may be an outdated guideline that hasn’t kept up with your current reality. Considering the rule before making a purchase can help give you a quick reality check.
Stick to cars you can afford, as you alone know how deep or shallow your pocket runs. Then, you can use this rule of thumb as a guideline rather than a strict rule you must follow.
Remember this is only a guideline that can inform your decision. It’s impossible to make it fit every person’s situation. You may decide to spend more money on a car because it’s something you truly value or because you must have a reliable vehicle to keep a job. Others may decide to spend less on a car because they’d rather allocate their money elsewhere.